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Cryptocurrencies and Regulation

24 Oct 2018

Bitcoin was born nine years ago as an anarchic project — a digital currency detached from any central bank. It promised a revolutionary alternative to the existing international payments system, where a central administrator was replaced by a multitude of decentralised digital verification points. Bitcoin and the technology it uses, blockchain, are drifting towards the mainstream. Regulators have their sights set on bitcoin and other cryptoassets it inspired. More than 75 of the world’s biggest banks, meanwhile, are turning to blockchain to fight the threat of new payments rivals.

The regulatory attention had become inevitable after bitcoin’s wild swings in value — which at its peak was yo-yoing by as much as 20 per cent in a day but has slumped from $19,000 last December to about $6,500 today. Bitcoin was followed by other types of cryptocurrency, the creation of exchanges, brokers and providers of wallets, or apps for holding and transacting in cryptocurrencies. There has been alarm, meanwhile, over security breaches and the potential use of such networks for money laundering and terrorist financing activities.

In a sign of authorities waking up to the risks, a UK parliamentary committee earlier this month called the cryptocurrency space a “Wild West” and urged regulation. The New York attorney-general’s office published a report this month denouncing “pervasive” conflicts of interest at many cryptocurrency exchanges and lack of sufficient measures to prevent market manipulation. The EU has included cryptocurrency exchanges and wallets in the fifth iteration of its anti-money laundering directive, due to come into force in 2019. The Financial Action Task Force, a global anti-money laundering organisation, is also looking into the crypto market.

Given the many risks, regulatory attention is overdue. Crypto investors currently expose themselves to unregulated risks that can completely wipe out their investments; values are based largely on sentiment, not fundamentals. But the useful innovation that is associated with the cryptocurrency world should not be overlooked.

Blockchain technology may be a good example. While its application as a payment mechanism on the high street is hindered by limits to the volumes it can handle, and the time and cost of verifying transactions, it has proved useful in cross-border transactions. Hence the decision by more than 70 banks, including Société Générale and Santander, to join a network that JPMorgan, Royal Bank of Canada and ANZ have been trialling to see whether blockchain’s distributed ledger technology can speed up resolution of payments that have errors or require additional compliance checks. Walmart, the US retailer, is starting to use blockchain to track certain products.

Proper regulation of cryptoassets will also make it respectable for traditional financial groups to have relationships with them. At present, banks that serve crypto players prefer to keep the links private. While some crypto market participants value the lack of transparency, such as certain coins that offer the lack of traceability, others welcome regulatory scrutiny.

This is a highly complex market. Regulators are still working out how to police it, but as cryptoassets and technology move into broader use by growing numbers of people around the world, a co-ordinated and appropriate regulatory framework is needed. The future of the crypto world may be greater technical and regulatory integration with mainstream finance.

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